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Playlist “Conflict of Interest”, Binky Mack “Disagree”, Chantal Kreviazuk “Hide and Seek”, Ani di Franco “Did You Get My Message? ”, Jason Mraz “Joint Venture”, Staffan William-Olsson “Silent Agency”, Silent Agency

Hidden Action I SI 680, ICD: Contracting and Signaling Jeff Mac. Kie-Mason

Information professionals need to manage many resources to succeed.

Information professionals need to manage many resources to succeed. Including people.

Agents use your expensive resources, but you can’t always monitor what they do

You must learn to manage without control. BY: Owen. Blacker (flickr) http: //creativecommons. org/licenses/by-nc/2. 0/deed. en

You succeed if your independent agents want to solve your problems.

Design agreements that motivate agents to self-monitor.

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Perfect contracts with perfect information can solve this problem.

Contract The party of the first part and the party of the second part hereby agree that: If x 1 happens, do y 1, get paid z 1; If x 2 happens, do y 2, get paid z 2; If x 3 happens, do y 3, get paid z 3… Elmer Fudd Alfred E. Neuman Elmer Fudd, Esq. Newman Alfred E.

Death penalty for parking violations Ines Macho-Stadler and J. David Perez-Castrillo, An Introduction to Economics of Information: Incentives and Contracts, 2 nd ed. (Oxford University Press, 2001), pg 281.

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© 2006 AOL

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The information requirements for perfect contracting are prohibitive.

bounded rationality

memory

communication

computation

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Source: Unknown

silicon-based

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What are some solutions?

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commitment

Xiang Yu

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Photo tour of factory: http: //forums. vwvortex. com/zerothread? id=1837641 BY: j. sp (flickr) http: //creativecommons. org/licenses/by-nc/2. 0/deed. en

contracts

© 2008 Peterson's Nelnet, LLC. All rights reserved.

Gabor Varszegi

fotex pay 4 x the market wage

Canonical contracting problem Principal contracts with agent to carry out some type of action or make some decision – principal designs and offers the contract(s) – agent freely chooses whether to accept (IR) – agent performs, but has some information not available to principal

Mount-Reiter diagram Objective function Environment Outcome messages, actions payoff function Message space

Canonical contracting problem Principal contracts with agent to carry out some type of action or make some decision NB: Fundamental conflict of interest: Cost for one is benefit for other. NB: Verifiability is critical issue: What is enforceable?

1. Agency cost When principals and agents have conflicting objectives, and asymmetric info… – …Can’t expect the organization or community (etc. ) to function as well as it would with full information or aligned objectives Shortfall: agency cost

2. Information rent Principal transfers part of surplus to agent to overcome agency cost: this is the agent’s compensation. Compensation = reservation utility + information rent

Dissolving a joint venture

How to agree on price for a departing participant?

2 agents, self-regarding, monotonic preferences: prefer xi to yi iff xi > yi Message space: vi, announced valuation for share. Problem: How to decide payment given the vi?

What’s wrong with the following mechanisms?

Departing partner announces her vi at departure date. Partner has to buy her out at that price

Agree on buyout price at contract commencement date.

Departee announces vi at departure date. Partner chooses to buy at that price, or sell his half to departee at same price.

Proof of incentive compatibility Suppose share is worth w to both partners (but they don’t know the value to the other) – If you announce v>w, partner will sell to you for v, you will lose – If you announce v

Pareto optimal Everyone at least as well off as before, no one worse No other result is Pareto superior Cf. Pre-nuptial agreements

But, not so fast… What if the partners have different beliefs about the true value? d b – Suppose w 1 є [a, b], and w 2 є [c, d] with a w 1, risking having to buy other share at higher price, but hoping to sell own share at higher price

But, not so fast… What if the partners have different beliefs about the true value? d b – Suppose w 1 є [a, b], and w 2 є [c, d] with a w 1, risking having to buy other share at higher price, but hoping to sell own share at higher price

Discussion • In this setting (bilateral trade with overlapping value supports) no mechanism can guarantee that its outcome will be: – efficient – budget balanced – individually rational • For example, for any mechanism there might be cases where w 2 > w 1, so there is some price at which both parties are better off if one partner sells to the other, but for which trade will not occur: Myerson-Satterthwaite (1981)

Humans are crucial devices in any system.

They are autonomous and (generally) at least somewhat self-interested.

Most tasks that require cooperation or agency (effort on behalf of someone else) have intrinsic conflict of interest.

Conflict of interest

Not swear words.

Learn to love them.

They create an opportunity for smart ICD professionals: Problems to solve.